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Wednesday, 7 March 2012

Subtenants - What Happens if Your Landlord Goes Bust?

If you're thinking of taking a sublease, you’d be wise to do some due diligence on the financial health of your prospective landlord.

That’s the advice given by Alexandra Lethbridge in an interesting article published in the Estates Gazette (11 February 2012) (£).

In 2011 I wrote What Happens If Your Landlord Goes Bust? which, as well as looking at landlord insolvency generally, touched on some of the problems that can arise if your landlord is also itself a tenant (so you have a sublease).

Let’s assume for the purposes of this post that the head landlord doesn’t want to forfeit the head lease (which would in turn bring your sublease to an end); after all, it’s unlikely to want to be left with empty premises in the current market, especially in view of the burgeoning liability for empty rates.

If the head landlord wants to preserve the income stream from you, its subtenant, the best outcome for everyone would be for it to negotiate with your immediate landlord’s insolvency practitioners (most likely a liquidator or administrator) for a surrender of the head lease.

If the head lease is surrendered, you will automatically become the direct tenant of the head landlord on the continuing terms of your sublease; so effectively there’s no change, you just have a different, and hopefully more solvent, landlord.

Things can become more complicated if the head lease is not surrendered.

If your landlord has gone into liquidation, then the liquidator has the power to disclaim the head lease as “onerous property”.

Disclaimer is not the same as surrender.

If the head lease is disclaimed, your interest in the property is not brought to an end, but your sublease itself no longer governs the terms of your occupation (so effectively your sublease no longer exists).

What does that mean?

In practice, it means that the only way you can remain in the premises and avoid forfeiture is by paying the rent reserved by the head lease and complying with the covenants set out in the head lease, even if they are more onerous than the ones that were in your sublease.

But it doesn’t mean you become the tenant under the head lease.

This situation is hard to analyse as it amounts to an unusual hybrid.

In her article, Alexandra explains that the head lease remains in existence “to the extent necessary to support the subtenant’s occupation”; so rather than having a continuation of the sublease, you have instead a collection of assignable property rights in the disclaimed head lease.

You might be able to apply to the court for a vesting order vesting the head lease in you (the rules are quite complex).

That would result in a lease that was properly enforceable between the parties and would at least clarify the situation legally.

The downside is that the new lease would be on the same terms as the head lease, not your old sublease, which may not be what you want, especially if you only had a sublease of part of your landlord’s property.

The court unfortunately does not have the power to vary the head lease to make it compatible with your old sublease.

If you decide to do nothing, the head landlord can force the issue by asking you to choose whether you want to have the head lease vested in you, or to be excluded from all interest in the property (which would mean you would have to leave), although whether it takes such a heavy-handed approach will depend on its chances of finding another occupier willing to accept the more onerous terms.

If there are a number of subtenants of different parts of the property, the court has to “weigh up all the circumstances”.

What that might mean in practice is unclear.

That’s why it makes sense to try and do some financial due diligence on your landlord before you take on a sublease.

It won’t offer any long term guarantees, but it might alert you to an imminent problem.

UPDATE 19/2/2013 - The above post is almost a year old, but still seems to be a popular one on this blog - a continuing and troubling sign of the times. If I come across any more recent examples of what can happen when an immediate landlord of a subtenant goes bust, I'll do a follow-up post. If anyone else meanwhile has any examples, I'd be delighted to hear from them.

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